Default probabilities in structured commodity trade finance

PurposeWe develop a model to predict the default probabilities in structured commodity trade finance transactions.Design/methodology/approachWe develop three hypotheses concerning the determinants of the probability of default in SCTF transactions. Then we describe the sample and the data collection process and introduce the statistical logistic regression technique utilized to evaluate the resulting dataset.FindingsOur results show that besides common financial ratios, the likelihood of default is influenced by commodity trade finance-specific characteristics such as the type of commodity involved and the transaction’s structure. Other factors, such as the obligor’s country and the transaction's tenor, seem to be of lesser relevance.Research limitations/implicationsOur study provides further research direction. The impact of recovery post-default is a crucial aspect that can provide deeper insights into the dynamics of defaulted SCTF transactions. The security package – which may include collateral like the financed commodity itself, guarantees or other forms of security – can play a vital role in reducing or eliminating losses.Practical implicationsThe implications for stakeholders, including financial institutions, commodity producers, traders, policymakers and the broader economy, are considerable. By identifying key drivers of default in SCTF transactions, our research offers valuable insights that can enhance risk management practices within financial institutions, leading to more prudent lending and underwriting decisions. This research shows that the type of commodity – specifically soft commodities and metals – positively influences the probability of default in SCTF transactions.Social implicationsOur research provides further insight that emerging markets – compared to developed markets – do not significantly contribute to default risk in SCTF transactions, which could open broader investment opportunities. Financial institutions may be more willing to lend and participate in SCTF transactions in these markets, increasing capital flow to emerging markets. This may promote economic development, infrastructure growth and the overall economic integration of these regions into the global economy.Originality/valueAccording to the current state of science, there is relatively little empirical evidence for the factors influencing the probability of default for SCTF. No empirical study to date has connected default risk with SCTF based on actual transaction data. We address this gap by examining the significant factors influencing default risk.